Assets & Acronyms (AA)…
You know, I recently looked back on my education, exams, and all the hoops I had to jump through to get here (not to mention the hoops I’m still jumping through), and I had a bit of a realization. Investing money and getting it to grow is remarkably simple, but we in the finance world have cooked up so many complications, rules, exclusions, tax implications, and finance terms that it’s dizzying. Now my entire job is to help others understand the craziness it has become and simplify it back down. It’s like taking spaghetti noodles out of a box, cooking them, and trying to put them back exactly as they were.
Investing at its core is easy. For example, let’s say I give Frank (a fictional business owner I just made up) $100. Frank then uses that money to buy a lawnmower and earns $200 mowing lawns that same day. He then gives me back my $100 and an additional $10 for loaning him the money. Just like that, I’m now a successful investor and I quit my job to go looking for more Franks to loan money to. It’s incredibly simple.
But that’s not real life. “Real life” it looks more like this:
I earn $100 a day at my job, but the government is convinced they get some of that. I’m in the 22% tax bracket, so I’ll have to pay income taxes at some point. To invest that money, I first have to pick an “investment vehicle” to use. That’s something like a Roth IRA, a Traditional IRA, a regular brokerage account, or my employer’s business investment plan (SEP, SIMPLE, 401(k), 403(b), 457, etc.). All of these have slightly different rules, contribution limits, and tax treatment. Then I choose the actual investments to go in that investment vehicle (stock, bonds, mutual funds, ETF’s, REITs, hedge funds, cryptocurrencies…). They all do the same thing. They take your money and turn it into more money, just like Frank did. At least they’re supposed to.
See? That paragraph alone is filled with enough numbers and acronyms to make some readers zone out or leave the blog. I get it! We’re going to start with “Investing 101”, the survival skills, the bare necessities.
IRAs.
I’m sure you’ve heard of them: Individual Retirement Accounts. You can set these up all by yourself through various apps and institutions, you don’t even need your employer. There are two main players in this arena: “Traditional” and “Roth”. If you’re only interested in the answers in the “back of the book”, skip past the bullet lists and notes.
For those still with me, open your textbooks to page 101.
Traditional IRAs:
Good: Your money is invested before you pay income taxes. That means all $100 you earned today is invested and starts compounding.
Bad: When you take the money out, you pay income taxes on everything (contributions and earnings).
A couple other fun complications and rules:
Since this is supposed to be for retirement, if you take money out before you are 59 ½, you get socked with an additional 10% penalty.
Since the government wants to collect their taxes, you must start taking out money by 73. This is called “required minimum distributions” or RMDs.
In 2024 you can only invest $7,000 a year, or $8,000 if you are 50 or older (catch-up contributions).
Roth IRAs:
Bad: Your money is invested after tax, which means you can only invest $78 of the paycheck above (depending on your tax bracket).
Good: When you take the money out, you pay precisely zero in taxes. That’s right, the government gets nothing. We advisors really like that feature.
Rules and the lack thereof:
You still have to keep the money invested until you are at least 59 ½.
There are no RMDs, so if you don’t need it, that money can keep growing exponentially.
The amount you can contribute per year is the same as a traditional IRA.
Note: The contribution limits apply even if you have both a Traditional and a Roth IRA. That means you can only invest $7,000 total per year in any IRA. You can invest it all in your traditional, go half and half ($3,500 in each), invest it all in your Roth, or do anything in between. You can’t invest $7,000 in both in the same year. Also, this must be earned income, meaning if you don’t make at least $7,000, you can’t contribute that much.
*School bell rings*
Both types make sense in different circumstances, it’s just a matter of doing the math. If you are uncertain as to which option is best for you, consider speaking with an investment professional, they get this question all the time. It’s very important to set up the right one at the right time. If you set up one when you should have set up the other, the tax guys get enough money to plan a nice vacation.
I love quotes, so I’ve decided to drop one in every post, investment-related or not:
“The grass isn’t always greener on the other side; the grass is greener where you water it.”
Have a good quote for the blog? Something I could’ve cleared up better?
brett@centennialsec.com or use the “Contact” tab above for feedback and questions.
